The singular focus of public debate on the “top 1 percent” of households overlooks the
component of earnings inequality that is arguably most consequential for the “other
99 percent” of citizens: the dramatic growth in the wage premium associated with higher
education and cognitive ability. This Review documents the central role of both the supply
and demand for skills in shaping inequality, discusses why skill demands have persistently
risen in industrialized countries, and considers the economic value of inequality alongside
its potential social costs. I conclude by highlighting the constructive role for public policy in
fostering skills formation and preserving economic mobility.

Public debate has recently focused on a subject that economists have been ana- lyzing for at least two decades: the steep, persistent rise of earnings inequality in the U.S. labor market and in developed
countries more broadly. Much popular discussion of inequality concerns the “top 1 percent,”
referring to the increasing share of national income accruing to the top percentile of households. Although this phenomenon is undeniably
important, an exclusive focus on the concentration of top incomes ignores the component
of rising inequality that is arguably even more
consequential for the “other 99 percent” of
citizens: the dramatic growth in the wage premium associated with higher education and,
more broadly, cognitive ability. This paper considers the role of the rising skill premium in
the evolution of earnings inequality.

There are three reasons to focus a discus-sion of rising inequality on the economic pay-off to skills and education. First, the earningspremium for education has risen across a largenumber of advanced countries in recent dec-ades, and this rise contributes substantially tothe net growth of earnings inequality. In theUnited States, for example, about two-thirdsof the overall rise of earnings dispersion be-tween 1980 and 2005 is proximately accountedfor by the increased premium associated withschooling in general and postsecondary edu-cation in particular (1, 2). Second, despite alack of consensus among economists regard-ing the primary causes of the rise of very topincomes (3–6), an influential literature findsthat the interplay between the supply anddemand for skills provides substantial insightinto why the skill premium has risen and fallenover time—and, specifically, why the earningsgap between college and high school graduateshas more than doubled in the United States overthe past three decades. A third reason for focus-ing on the skill premium is that it offers broadinsight into the evolution of inequality within amarket economy, highlighting the social value ofinequality alongside its potential social costs andilluminating the constructive role for public policyin maximizing the benefits and minimizing thecosts of inequality.

The rising skill premium is not, of course, the
sole cause of growing inequality. The decades-long decline in the real value of the U.S. minimum wage (7), the sharp drops in non-college
employment opportunities in production, clerical,
and administrative support positions stemming
from automation, the steep rise in international competition from the developing world,
the secularly declining membership and bargaining power of U.S. labor unions, and the
successive enactment of multiple reductions in
top federal marginal tax rates, have all served to
magnify inequality and erode real wages among
less educated workers. As I discuss below, the
foremost concern raised by these multiple forces
is not their impact on inequality per se, but
rather their adverse effect on the real earnings
and employment of less educated workers.

I begin by documenting the centrality of the
rising skill premium to the overall growth of
earnings inequality. I next consider why skills
are heavily rewarded in advanced economies
and why the demand for them has risen over
time. I then demonstrate the substantial explanatory power of a simple framework that
embeds both the demand and supply for skills
in interpreting the evolution of the inequality
over five decades. The final section considers
the productive role that inequality plays in a
market economy and the potential risks attending very high and rising inequality; evidence on
whether those risks have been realized; and
the role of policy and governance in encouraging skills formation, fostering opportunity,